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Daily Capital

China Drives Emerging Market Selloff and Flight to Safety

Market Digest – Week Ending 1/24

Stocks were up modestly for the first two days following Martin Luther King, Jr. Day, with gold and Treasuries modestly down. These trends sharply reversed following China’s disappointing manufacturing report on Thursday, causing investors to flee all risky assets. The S&P 500 ended the week down -2.6%, with emerging market stocks down -4.7% on Thursday and Friday alone. Investors found safe havens in gold and developed market bonds, which both ended the week in positive territory.

Weekly Returns:

S&P 500: 1,790 (-2.6%)
FTSE All-World ex-US: (-3.1%)
US 10 Year Treasury Yield: 2.72% (-0.10%)
Gold: $1,269 (+1.3%)
USD/EUR: $1.368 (+1.1%)

Major Events:   

  • Monday – Martin Luther King, Jr. Day.
  • Tuesday – Mohamed El-Erian announced he is stepping down as CEO of Pimco, leaving Bill Gross as the firm’s sole chief investment officer.
  • Wednesday – EBay unveiled a $5 billion share buyback program and said it rejected a proposal from Carl Icahn to spin off its PayPal division.
  • Thursday – China’s preliminary manufacturing Purchasing Managers’ Index came in weaker than expected, sparking a sell-off in emerging market and global stocks.
  • Friday – Thursday’s global sell-off continued as investors fled all risky assets.

Our Take:

Emerging market stocks sold off sharply over the past couple of days. Two major drivers are at play: China and fears of rising interest rates. On Thursday, the preliminary manufacturing Purchasing Managers’ Index for China came in below expectations, indicating contraction. Investors were hoping for an improvement after its economy slowed in the fourth quarter of last year. The weaker than expected reading, coupled with ongoing fears of US Fed tapering, sparked a sell-off in both emerging market stocks and certain EM currencies. The downward trend continued on Friday with investors fleeing virtually all risky assets, including developed markets stocks.

There’s no denying a slowdown in China would adversely impact EM growth, but this has been on the radar for some time now. The country is in the process of transitioning from an export based economy to one of domestic consumption. As such, there will naturally be bumps in the road. It is too early to claim Thursday’s weaker than expected manufacturing reading as indication of a full blown slowdown.

There is also a fear that emerging market countries will not be able to support growth should the US Federal Reserve unwind stimulus measures and drive up interest rates. While this could certainly make conditions more challenging, we don’t believe it warrants full blown panic selling. EM countries have significantly improved their balance sheets in recent years. According to the IMF, government debt has fallen from 48.7% of GDP in 2000 to 34.7% in 2013. There may be spots of weakness, but in aggregate the region is much better prepared to handle currency and growth volatility than in the past. Moreover, improving economic conditions in the US and Europe should help bolster demand for EM exports over time.

This is a kneejerk reaction, and we do not believe it is time to abandon EM stocks altogether. They continue to play an important role in well-diversified investment portfolios, and should benefit over the long-term from faster economic growth relative to developed markets.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Brendan Erne serves as the Director of Portfolio Management at Personal Capital. After several years as an equity analyst covering the technology and communication sectors, he joined Personal Capital in 2011, just before its official launch to the public. He helped create and manage the firm’s investment portfolios and build out the broader research team. He also co-authored Fisher Investments on Technology, published by John Wiley & Sons. Brendan is a CFA charterholder.
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